In the United States, there is talk of a backlash against ESG, while in Europe, the number of laws requiring companies to comply with ESG standards is growing steadily. This difference in attitude and approach toward ESG may, in part, be explained by the structures of the U.S. and EU financial systems. While the U.S. system is market-centric, aimed at raising capital from the public and so much more responsive to the preferences of investors, the EU system is bank-centric, meaning it is strongly tied to the provision of credit by banks. In Europe, banks are an important lever for moving companies that need access to credit markets toward more environmentally friendly policies because banks use the Green Asset Ratio (GAR), which is a Key Performance Indicator quantifying EU Taxonomy aligned assets as a percentage of total covered assets.

However, the U.S. and EU are not as far apart on sustainability as they may seem. In both cases, ESG factors are tools to generate profit rather than just goals to be pursued at the expense of profit.

To demonstrate this, I compare the major legislative changes in both the U.S. and EU legal systems.

EU Law: the Measurement and Disclosure of ESG Factors

The main EU laws are: Regulation (EU) 2019/2088 (Sustainable Finance Disclosures Regulation or “SFRD”); Regulation (EU) 2019/2089 amending Regulation (EU) 2016/1011 (“Benchmark Regulation”); Regulation (EU) 2020/852 (“Taxonomy Regulation”); Directive (EU) 2022/2464 (“Corporate Sustainability Reporting Directive” or “CSRD”); and, lastly, the very recent Directive (EU) 2024/1760 on corporate sustainability due diligence (“Corporate Sustainability Due Diligence Directive” or “CS3D”).

The SFRD is designed to reduce market information asymmetries by requiring financial market participants and financial advisers to disclose how ESG factors are incorporated into their investment decisions and advice. Thus, the ultimate targets of the transparency rules are investors who buy and sell financial products. The regulation defines “sustainable investment” as an investment in an economic activity that contributes to an environmental objective, “as measured…by key resource efficiency indicators,”[1] to a social objective or an objective of governance.

The “measurement” of environmental, social, and governance objectives is crucial for determining financial risks. The Benchmark Regulation and the Taxonomy Regulation directly affect how ESG information is communicated. The former introduced two types of low carbon benchmarks: (i) The EU Paris-Aligned Benchmark (EU PAB); and (ii) The EU Climate Transition Benchmark (EU CTB). The latter – establishing a framework to promote sustainable investments and amending Regulation (EU) 2019/2088 – contains, by contrast, a specific classification system of economic activities that can be defined as sustainable.

These regulations are also primarily aimed at the protection of investors and consumers and the functioning of the market. The Taxonomy Regulation plays a central role in the context of the European legislation aimed at regulating sustainable finance. This is because it created a specific “lexical system” through which it is possible to communicate data relating to environmental pollution. This step appears to be mandatory and necessary for the construction of sustainable finance that contributes to the implementation, also in the real economy, of ESG factors[2].

The CSRD and CS3D moved in the same direction. The CSRD takes a forward-looking perspective aimed at creating a long-term horizon for the financial market and the real economy.[3] The regulation modified the Corporate Sustainability Reporting rule, which was introduced into the European legal system by Directive 2014/95/EU (non-financial reporting directive or “NFRD”). Among other reforms, it expanded the subjects covered by sustainability reporting, provided for the placement of sustainability reporting in balance sheets, and introduced the principle of “double materiality” for the selection of relevant information. The CSRD introduced the Sustainability Report, which also requires non-European companies that have a subsidiary (whether a large company or a small or medium-sized listed company) to draw up a report on sustainability issues. It will be interesting to see whether the enforcement tools of the public authorities of the individual EU Member States will be effective against holding companies that do not operate directly in the European market.

Lastly, the most recent of the EU acts mentioned here is the Directive 2024/1760/EU (Corporate Sustainability Due Diligence Directive or CS3D), which establishes a corporate due diligence duty[4]. The core elements of this duty are identifying and addressing potential and actual adverse human rights and environmental impacts in the operations of a company, its subsidiaries and, where related to its value chains, those of its business partners.

The European approach is primarily focused on transparency regarding the impacts of business activities on ESG factors and vice versa, and thus on the standardization and measurement of sustainability goals. In other words, it seems that information generates an economic value, which the legislation aims to protect. This is demonstrated by the fact that the main concern of the European regulations is investors[5]. Meanwhile, American regulations attempts and laws seem aimed toward a similar goal.

U.S. Regulatory System: Standardizing Climate-Related Disclosures

Though not as stringent as European rules, there are various U.S. regulations and initiatives that influence transparency on ESG[6]. For example, the Securities and Exchange Commission “SEC” recently adopted rules to enhance and standardize climate-related disclosures by public companies and in public offerings. Their aim is to provide information for investors that is consistent, reliable, and comparable regarding the financial effects of climate-related risks. The SEC rules (like the European ones) require that registrants declare not only the effects of their business activity on the climate, but also the actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook. Therefore, as required by CSRD, information should be selected on the basis of that “double materiality” criterion.

In October 2023, California approved two bills that impose reporting requirements on companies meeting certain thresholds: the Climate Corporate Data Accountability Act and the Climate-Related Financial Risk Act, which requires biennial reporting of climate-related financial risk, in line with the recommendations of the Task Force on Climate-related Financial Disclosures.

Recently, the United States also adopted measures against greenwashing, defined as  the provision of misleading ESG information. The SEC adopted amendments to the Investment Company Act providing for the “names rule,” which addresses fund names that are likely to mislead investors about a fund’s investments and risks. These are changes aimed at eliminating unfounded claims by funds regarding their ESG credentials, and imposing greater standardization of such disclosures, in order to protect investors. Furthermore, in 2022, the SEC proposed a rule to improve the reporting of certain investment advisers and investment companies on ESG practices. The rule proposes three types of ESG investment funds: Integration Funds, ESG-Focused Funds, and Impact Funds.

Finally, ne of the main pillars of U.S. legislation against human rights violations is the Alien Tort Statute (“ATS”), which grants U.S. courts jurisdiction in civil cases involving systemic human rights violations and breaches of international law to the detriment of foreign victims. The ATS has had the effect of making human rights violations (regardless of where they occur) a liability on the balance sheet of companies. Europe does not have a similar law, but it is moving towards empowering the global-governance function of multinational corporations. An example of this is the Sustainability Report, which must be prepared by the non-European holding company that has a branch or subsidiary in EU territory.

Conclusion 

There has been a clear maturation of corporate social responsibility (“CSR”) from its original concept as an ethical and moral responsibility of corporations (and especially big corporations) to a practice of increasingly financial value. CSR now seems aimed at combining the principle of “Do No Significant Harm” (“DNSH”)^[7] and corporations’ interest in maximizing profits. This is demonstrated by the increasingly important principle of disclosing information  to the market[8].

 Information becomes both a tool to reduce negative externalities of companies (and therefore also the risk of market failures)[9] and a way to reduce information asymmetries in capital markets while  improving trust in, and attracting capital to, corporations.

Both the EU and U.S. approaches to sustainability aim mainly for two objectives:

(i) to ensure that information is reliable so that it builds trust in the markets operators and to reallocate capital towards sustainable objectives; and

(ii) to make ESG factors also financial factors that should be considered and managed in the development of companies’ business models and strategies, especially in the long term.[10] This is made evident by the criterion of “double materiality,” which calls for the ESG risks to the undertaking (outside-in information) and the impacts of the undertaking on ESG factors (inside-out information) to be seen from one materiality perspective.

Although the numerous and complex European measures seem to lead to different objectives than do U.S. measures, which impose fewer burdens on corporations,[11] both legal regimes promote a vision of CSR as a tool for profit maximization.

ENDNOTES

[1] Article 2, n. 17, Regulation (UE) 2019/2088.

[2] Indeed, the SEC highlighted the danger that the void of standards, benchmarks and definitions will fuel the business of “alleged” ESG experts («ESG is broad enough to mean just about anything to anyone»). See H. M. Peirce, SEC Commissioner Peirce Talks Flaws in Scoring Companies on Environmental, Social, and Governance Factors, in The CLS Blue Sky Blog, June 24, 2019.

[3] On long-termism see M. Stella Richter, Long-Termism, in Riv. Soc., 1, 2021, p. 16.

[4] The main question raised by European doctrine is whether the obligations deriving from the CSRD and the CS3D are suitable for extending the fiduciary duties of the directors of large companies M. Libertini, Gestione “sostenibile” delle imprese e limiti alla discrezionalità imprenditoriale, in Contratto e impresa, 1, 2023, p. 55. On U.S. directors’ fiduciary duties, see C. Myers – J. J. Czarnezki, Sustainable business law? the key role of corporate governance and finance, in Environmental Law, 2021, Vol. 51, No. 4 (2021), p. 1003 and on the increasing pressure to use environmental, social, and governance (ESG) factors in making investment decisions, See M. M. Schanzenbach – R.H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, in Stanford Law Review, vol. 72, February 2020, p. 381 ss.

[5] G. Balp – G. Strampelli, Institutional investors as the primary users of sustainability reporting, in The Cambridge Handbook of EU Sustainable Finance: Regulation, Supervision and Governance, a cura di K. Alezander – M. Siri – M. Gargantini, Cambridge, 2023, p. 1-23.

[6] According to some studies, among the transitions in progress in the U.S. market is the new (and growing) demand among investors for ESG information. See J. C. Coffee, The Future of Disclosure: ESG, Common Ownership, and Systematic Risk, in ECGI Working Paper Series in Law,Working Paper N° 541/2020, March 2021, p. II. “Two reasons underlie this demand for more information: (1) ESG disclosures overlap substantially with systematic risk, which is the primary concern of diversified investors; and (2) high common ownership enables institutions to take collective action to curb externalities caused by portfolio firms, so long as the gains to their portfolio from such action exceed the losses caused to the externality-creating firms.”). In Europe, on the role of institutional investors in pursuing ESG objectives, see M. Maugeri,Institutional investors and “responsible” capitalism, in Riv. ODC, 3, 2023, p. 836.

[7] Art. 17 of Regulation (UE) 2020/852.

[8] F. Lopez-de-Silanes – J. A. McCahery – P. C. Pudschedl, ESG performance and disclosure: a cross-country analysis, in Singapore Journal of Legal Studies, March 2020, pp. 217-241.

[9] R. Cooter – T.  Ulen, Law and Economics, 6th edition (2016). Berkeley Law Books. Book 2, 2016, p. 39 (“The reason the market fails in the presence of external costs is that the generator of the externality does not have to pay for harming others, and so exercises too little self-restraint. He or she acts as if the cost of disposing of waste is zero, when, in fact, there are real costs involved, as the people downstream can testify. In a technical sense, the externality generator produces too much output and too much harm because there is a difference between private marginal cost and social marginal cost”).

[10] “It is true that ESG issues may well be relevant to a company’s long-term financial value (H. M. Peirce, SEC Commissioner Peirce Talks Flaws in Scoring Companies on Environmental, Social, and Governance Factors, in The CLS Blue Sky Blog, June 24, 2019). Furthermore, on the connection between profitability and social responsibility, G. L. Clark – A. Feiner – M. Viehs, From the stockholder to the stakeholder. How sustainability can drive financial outperformance, March 2015, p. 10. About the profitability of investing according to ESG criteria in the U.S. and Europe, see C. E. Bannier – Y. Bofinger – B.Rock, Doing safe by doing good: ESG investing and corporate social responsibility in the U.S. and Europe, in CFS Working Paper Series, No. 621, p. 1.

[11] U.S. legislation on sustainability issues is mostly based on voluntary measures. For example, even before the proposal of the ESG Disclosure Simplification Act, many U.S. issuers listed in regulated markets, due to pressure from institutional investors, were already publishing “non-financial reporting” on a voluntary basis.

This post comes to us from Lodovica Rocco di Torrepadula, a research fellow at the University of Brescia in Italy.